Politicians fear leaving pension casino

I don’t envy Dianne Jacob and Dan McAllister, the elected officials on the board that runs San Diego County’s $9.6 billion pension fund.

Pension costs are causing municipal bankruptcies from Stockton to Detroit, so the officials are suddenly in very hot seats.

To be clear, San Diego County is a long way from bankruptcy. Yet relative stability could be fleeting, because local officials are making expensive bets with taxpayer and retiree money.

Jacob, a county supervisor, and McAllister, county treasurer, face a decision that should be familiar to anyone trying to retire comfortably: Pay a fortune to advisers in hopes of fabulous returns? Or invest conservatively and start saving more aggressively, understanding that frugality will require some painful lifestyle changes?

So far, the two elected leaders and board colleagues have opted for the exotic, expensive strategy. But it’s becoming unavoidably clear that the risks aren’t paying off.

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San Diego County’s pension fund ranked a dismal 84 out of 100 similar funds in the year ended Sept. 30; 72 over three years; and 84 over five years, according to an analysis released this week by Wurtz Associates, a consultant to the board.

Meanwhile, the county fund’s investment costs are among the highest in the nation, according to a recent survey of 241 public funds by the National Conference on Public Employee Retirement Systems. Most systems had aggressively cut costs.

Not so in San Diego County. Its actuary reported the fund spent a record $103.7 million in investment and administrative fees in the fiscal year ending June 30. That’s 1.13 percent of the fund’s $9.2 billion value at the time, nearly double the national median of 0.57 percent.

A big chunk went to Salient Partners, a consulting firm that got $7.2 million last year to manage the county’s portfolio. Millions more go to fund managers picked by Lee Partridge, Salient’s investing chief.

For perspective, the investment strategist for San Diego’s city pension fund — which posted better returns last year — makes under $200,000. Other staffers handle some work done for the county by Salient, but the cost is well under $1 million.

So the county fund pays dramatically more money to underperform other funds. What gives?

Like most bad ideas in investing, the county’s strategy arose from fear.

For years, officials prided themselves on their investing skills, using terms like “innovative” and “cutting edge” to explain use of hedge funds and other exotic investments.

Then the 2008 crash caused paper losses across most of the portfolio. But instead of being humbled by the experience, the board doubled down.

In October 2009, it hired Partridge after he presented a strategy purporting to cut risk while boosting returns.

Partridge has variously called the strategy “partial risk parity” or “risk allocation.” It boils down to diversification out of stocks (thus missing recent gains) and into Treasury futures, currencies, commodities, foreign bonds and other exotic trading positions.

The idea is that when stocks go down, other asset classes will do better. One problem is that classes tend to plunge together when markets are in turmoil, as in 2008 and briefly this summer.

Another big problem is that Partridge’s strategy tries to boost returns by using leverage — a form of borrowing — to bet on market movements. It’s like taking out a home-equity loan to bet on bonds.

Ultimately this expensive approach goes all the way back to 2001, when Jacob and her colleagues on the Board of Supervisors voted to raise lifetime benefits for county workers by 50 percent.

This decision instantly turned a surplus into a deficit, adding a $1.4 billion debt to a fund worth $3.7 billion at the time.

Supervisors borrowed $900 million to cover some of the shortfall, shifting risk from taxpayers to bond investors. But it’s been hoping for fat investment returns ever since to make up the difference.

The good news is that, despite his underperformance compared to other funds, Partridge has exceeded the county’s return assumption of 7.75 percent a year. So 2008 didn’t cause its present $2.4 billion unfunded liability.

But last month Partridge forecast that future returns will be closer to 6 percent, driven down by historically low interest rates and today’s high stock prices. He has suggested more leverage in the past.

It’s a challenge faced by all pension funds. Moody’s, the bond rating agency, has called for return assumptions as low as 5.5 percent.

That would roughly double the county’s unfunded actuarial liability, leaving taxpayers on the hook for $5.7 billion, according to an analysis early this year by Ed Ring of the California Public Policy Center.

This scares the pension board to death. Adopting a conservative, prudent investment strategy would require immediate cuts to government services, a big tax hike, or both.

Of course, the county’s predicament is far from unique. Public pensions pose about 10 times more risk to taxpayers and government budgets than in 1975, according to an analysis by Andrew Biggs, a scholar at the American Enterprise Institute.

The laws of finance — and politics — are immutable for Jacob and McAllister, the elected officials on the nine-member pension board.

Let’s suppose they do the prudent thing, and push for sharply higher contributions and a conservative investment strategy. If the next crash tests that strategy, they will be blamed.

So far, they have said and done little beyond voicing “serious questions” and “deep concern” in board meetings.

The irony is that, by taking the politically safe course of doing nothing, they are choosing considerable investment risk for the taxpayers and workers they represent.